Springtime for Hitler is the satirical opening number to Mel Brooks’ classic movie, "The Producers", where the juxtaposition of dancing stormtroopers both horrifies and entertains at the same time.
Springtime for mergers and acquisitions in the alternative investment space could potentially be a sequel: on the one hand, it's almost satirical to think about it, given the financial battle the world has just gone through and at the same time the optimism that asset managers are once again attracting buyers, even after being perceived as having lost the battle.
According to the latest M&A report by Jefferies Financial Institutions Group, it’s not satirical at all to be at least somewhat optimistic that the long, dark winter of zero M&A activity is over, or at least on its way back, if current trends continue (click here to download the full report; click here to read the press release).
Indeed, while global transaction activity for asset managers slumped during the first half of 2010, a growing backlog in deal activity will play out over the next 12-18 months driven by independent sellers seeking liquidity after standing on the sidelines since the onset of the financial crisis (click here to read AllAboutAlpha.com’s coverage of Jefferies’ report back in February; click here to read AllAboutAlpha.com’s additional M&A-related posts).
Once upon a time, before hell apparently did freeze over, there was much talk about mergers and acquisitions in the alternatives space. The story at the time was that investment banks would gobble up hedge fund firms in an effort to offer as many kinds of hedge fund products as they could, that funds of hedge funds would do the same and that even private equity firms would merge or acquire hedge funds in an effort to diversify and appeal to a broader set.
It was all great in theory, and in many cases it was true – Citigroup (C), Merrill (BAC), JP Morgan (JPM), and a host of other big-name investment banks scrambled over each other to write checks for hedge fund firms, much to the partners of those firms delight.
And then deal activity, for obvious reasons, hit the skids big-time.
But by Jefferies’ count, deal activity involving alternative asset managers is indeed back on the upswing, reaching a record level in 2010 representing 45% of deal activity in the asset management sector, compared with nearly half that level, 25%, in the first half of 2009 (see chart below).
Among the more prominent transactions: Strategic deals such as Man Group’s acquisition of GLG Partners, smaller divestitures like SkyBridge Capital’s acquisition of Citi Alternative Investments from Citigroup and more specific asset-class-related targeted deals in hedge funds, real estate, CDO/ CLOs and private equity fund-of-funds (PEFoF).
The largest PEFoF transaction completed in the first half of 2010, Northwestern Mutual’s divestiture of Pantheon Ventures, marked the second largest alternative transaction completed during the period in terms of AUM transacted, just behind Man Group’s acquisition of GLG Partners, and the largest control acquisition of an asset manager in the private equity sector ever.
Beyond improved economics, better valuations and other positives that making merging or acquiring a good idea, other positives including diminished concerns on the regulatory and taxation front and the usual “synergy” search for partners that are a good fit, says Jefferies. There’s also the other obvious motivator: a ton of cash on balance sheets that could and should be put to work.
Added to the equation, though, is the very strong desire to mitigate risk – meaning whatever the merger or acquisition may be, it is going to thought through well in advance.
“Many buyers are again comfortable deploying capital on M&A but seek out deals that carry both low execution risk and significant synergy potential,” said the report. “As a result, substantial domestic acquisitions are on the rise again, focusing on targets that offer complementary products and distribution channels.”
Another compelling reason for the M&A uptick is that hedge fund principals who didn’t get out before the global economic downturn now have a chance to sell their firms and cash out – something that wasn’t easy when times were good but was all but impossible after the market crash and Great recession. The chart below shows the percentage of independent divestitures in the asset management space.
So what does it all mean?
On the surface, it suggests the worst is over for M&A in general and for hedge funds managers in particular, especially those who ran good, tight ships through the good and bad and came through the storm intact. Before worrying about survival, one of the key issues many hedge fund principals faced was an exit strategy that got them out of the game without damaging the firm, the strategy or the investors – something typically only accomplished by merging or being bought out.
A compromise many hedge fund buyers and proprietors are looking at is allowing the next generation within an existing firm to keep some equity – as incentive to continue growing the business. Another more recent trend: Buyers willing to consider transaction structures that will share the benefit of future growth with the sellers. “For investment management boutiques, such value uplift is often more assured with a corporate partner, which is able to support a boutique’s growth with access to its sales network and institutional relationships,” says Jefferies.
Still, the deals aren’t exactly flying across the ticker, suggesting that hedge funds and other alternative shops still have an uphill climb ahead of them before they become appealing enough to spark buyers’ interest – or until they finally accept the fact that they’ll never sell the business at the price they think – or had hoped – its worth.
On the buyer side, perhaps there’s still trepidation that like Max Bialystock and Leo Bloom, investing in something that might be primed to fail to the benefit of its founders and creators might still be a risk.
Update: Click here for Part 2